The Conceptual Framework for General Purpose Financial Reporting

Introduction

Conceptual frameworks have increased in popularity and are being utilized in various fields
such as psychology, economics, accounting, education, and psychology. A conceptual framework
in each of these areas aims to provide a systematic and organized approach to comprehending a
matter to aid in study, evaluation, and decision-making. In the field of accounting, the conceptual
framework can be viewed as a basis for the establishment of accounting rules and the recognition
of financial statement elements such as assets, liabilities, income, and costs. This essay will
clarify the Conceptual Framework for General Purpose Financial Reporting and its objectives, as
well as present four important concepts of the framework, which are the historical cost, the
accrual basis, the going concern assumption, and the prudence concept. Moreover, some
challenges are encountered when applying the framework to financial reporting.

Explanation of the Conceptual Framework for Financial Reporting and its purpose

As a crucial component of financial reporting systems, a conceptual framework consists of a

set of principles and ideas that provide a unified understanding of the subject and ensure
consistent communication. Its primary aim is to establish a common language and thought
process for financial reporting, laying down fundamental principles and guidelines for creating
financial statements and interpreting financial data (Dennis, 2018). The Framework for the
Preparation and Presentation of Financial Statements was released in 1989 by the International
Accounting Standards Committee (ISAC), which is now recognized as the International
Accounting Standard Board (IASB). Subsequently, the IASB introduced modifications to this
framework, resulting in the issuance of a revised version under the title "The Conceptual
Framework for Financial Reporting" in 2010. The development of the framework spanned many
years, and the International Standards Advisory Board (ISAB) announced the final version in
March 2018, known as The Conceptual Framework for Financial Reporting, which serves as a
guiding document for financial reports.

To ensure the accuracy of recognition, measurement, and reporting, an accounting conceptual

framework defines critical terms and concepts, including assets, liabilities, revenues, and
expenses. Another crucial aspect of the conceptual framework is defining basic concepts and
presumptions. For instance, income and expenses should be recognized as they are acquired or
incurred rather than as they are received or paid, accurately reflecting an organization's financial
position and performance. In addition, the conceptual framework also establishes guidelines to
aid in the selection and implementation of accounting policies, ensuring that users of financial
statements receive reliable and useful information. As a result, financial data from multiple
businesses is uniform and comparable, enabling people to make wise decisions.
 An example where a conceptual framework finds practical use is when a business is
preparing its financial statements for the end of the year. Throughout the year, the company
bought a new building and intends to classify it as a fixed asset on the balance sheet. The
accounting team examines the conceptual framework and concludes that an entity classified as a
fixed asset must provide future economic benefits for the company and possess a quantifiable
cost. Then, the accounting team reached the conclusion that the new building meets the
necessary criteria and is eligible to be recognized as a fixed asset on the financial statement. The
criteria outlined in the conceptual framework are used to ascertain the appropriate depreciation
technique and make an estimate of the anticipated useful life of the structure. The accounting
team adheres to the principles and guidelines as outlined by the conceptual framework to ensure
the accurate preparation of the company's financial statements.

According to the conceptual framework, financial reporting's major objective is to furnish

financial information about a reporting business to current and prospective investors, as well as
lenders and creditors, with the intention of facilitating their decision-making processes
concerning the provision of resources to said entity (Alan Sangster, Frank Wood, 2018). The
facilitation of external users' decision-making is the main objective of General Purpose Financial
reports. This report presents an analysis of the financial status of the firm, including its assets and
liabilities. Additionally, it further furnishes valuable financial data about the business to current
and prospective investors, lenders, and creditors, leading to informed judgments pertaining to
allocating resources to the organization. The amount, timing, and level of uncertainty related to
inflows of future net cash to the business are all taken into account when determining the
expectations of investors, lenders, and other creditors about returns. To facilitate their assessment
of the potential for upcoming net cash inflows to the business, these stakeholders require the
aforementioned information (FASB, 2021).

Four key concepts in the Conceptual Framework

The historical costs concept

The concept is known as the "original purchase cost principle," and it states that assets should
be valued at the price they originally cost businesses to acquire at the time of the transaction
when they are listed in financial statements or accounts. If there is no exchange of money, the
asset will be replaced by an equivalent one (Bariyiama D. Kiabel, Ph.D., and Loveday A.
Nwanyanwu, Ph.D., 2014). Unlike current assets, including cash and trade receivables, which are
regularly transferred, this cost concept is mainly used for fixed assets (Tomasetti, 2023)
(Gowthorpe, 2020). This is because current assets' fair market value may be easily determined
due to their frequent transactions.

Clearly, the fundamental benefit of applying the historical cost rule in financial reporting is
that it helps decision-makers avoid controversies about prices. Historical cost is highly reliable
because it is unchanged and recorded by contract when a transaction occurs. The historical cost
idea prevents fair value markets from fluctuating based on arbitrary pricing as well as consumer
demand and a nation's economic situation (Thomas J. Carroll, Thomas J. Linsmeier, and Kathy
R. Petroni, 2003).

The prudence concept

According to the prudent concept in accounting, accountants should exercise care and
caution while assessing and analyzing aspects of financial statements including expenses, assets,
and liabilities (C. Richard Baker, Martin E. Persson, 2021).To be ready for a challenge in the
future, the accountants must prudently forecast the possible receipt of money. For instance, not
all debts could be paid off on time, or the debtors were insolvent. This concept also encourages
users not to overwrite the value of assets in the financial report. The amount of money is only
recognized by accountants who adhere to the prudence principle once trade contracts have
begun. The value of a transaction is not going to be included in a financial report if it only has
the potential to happen or lacks sufficient documentation or contracts. Additionally, users should
exercise caution when applying the prudence concept to describe the overall state of the
company's finances because doing otherwise could result in misleading financial statements
(Thakur, 2023).

As we can see, the accounting notion of prudence assists both internal and external decision-
makers when making an investment. Due to the predictable assumptions made by this idea
regarding debts, it is effective for business owners and shareholders to anticipate and handle
upcoming financial issues. Furthermore, this restriction prevents inflated income and assets,
which gives outside investors an accurate and comprehensive assessment of a business's financial
viability (Cooper, 2015).

The accrual basis

One of the two most crucial accounting principles that financial reports ought to pay attention
to is the accounting basis. According to this concept, transactions should be recorded as
economic occurrences rather than dependent on the timing of the associated receiving and paying
(Abdul Khan, Stephen Mayes, 2009). Matching features and recognizing revenue goals are the
two fundamental objectives of the accrual basis concept. The expenses and money earned over
the same period must match precisely in order to comply with the matching criterion. Moreover,
the revenue must be reported, whether or not it is collected. As an illustration, trade payable and
trade receivable are sums that a business will accrue or pay in the future but that are still included
on the balance sheet (Kelly, 2022).

It is obvious that implementing the accrual basis concept supports economic decisions when
it records previous transactions and future receivable amounts (David Alexander, Anne Briton,
2011). First, financial statements prepared in accordance with the accrual basis rule may aid
outside investors in making informed decisions. Based on the sums that the firm is required to
pay and the probability that assets will be collected, investors can assess the cash flow and ability
of the company. Besides, using this idea benefits the companies themselves since they can
quickly create a financial strategy using the information recorded in accordance with the accrual
basis norm. Businesses may be able to prevent losing money because their financial statements
adhere to the idea of noting the quantity of receivables as well as planning a suitable budget for
upcoming liabilities on the balance sheet. Finally, because it gives a business a trustworthy and
realistic picture, adhering to this accounting principle may increase a company's chances of
receiving investment from outside sources.

The going-concern assumption

When the idea of going-concern assumption is used, accountants presume that the financial
activities of a business will continue indefinitely in the foreseeable future without ever coming to
an end (Fremgen, 1968). Accounting professionals prepare financial statements using forecasted
asset and liability amounts in accordance with the going concern principle. Accountants
frequently base their decision to use the going concern premise on three key factors: the demand
of society for the business's products, the profitability of those items, and changes in local laws
affecting the business' operation (Tomasetti, 2022). For instance, Ms. Linda opened her fast-food
joint close to a primary school. She makes sure that kids like her product and that it makes
money. She also has sufficient legal documentation, a license, and a certificate for her business.
To predict her financial situation in the coming time, Ms. Linda will use the going concern idea
in this scenario.

When an owner can predict the financial health of their business and review past
transactions, the going concern principle benefits them (Jagdish Kothari, Elisabetta Barone,
2011). Decision-makers can find it useful to assess whether qualities have the potential to be
profitable in the future. In addition, when the balance sheet application of this concept
documents all assets and obligations in detail, owners can object attentively to the cash flow.

Challenges in applying the Conceptual Framework for Financial Reporting

Although the conceptual framework is established to improve decision-making and the

comparability and consistency of financial statements, there are still challenges in implementing
it for financial reporting. First, lack of flexibility in the structure of conceptual framework is
considered one of these difficulties. By providing a set of accounting concepts and rules, the
conceptual framework guarantees that financial statements are presented in a similar and
comparable way, enabling easier comparison of financial data between companies and countries.
However, this may not be appropriate for all businesses since various sectors and company types
may need different accounting approaches. Besides, the framework can be limited when
companies meet new data or special circumstances under which it cannot work effectively in
analyzing information for their financial report (Shkulipa, 2021). For instance, a household
appliance retail business that sells household goods through physical stores, due to technological
advancement, has joined e-commerce and online sales besides the traditional store.
Unexpectedly, a business experiences considerable declining revenue since shifting to this new
selling approach. The conceptual framework focuses on the matching principle; however, in this
scenario, expenses recorded by the company based on the principle become challenging as the
fall in earnings is not adequately matched with the constant costs of managing physical shops
and inventory. As a result, a business's financial reports do not reflect accurately its financial
condition and the sales problems it faces. Investors and stakeholders may not comprehend the
issue, leading to mistaken judgments.

Another challenge that needs to be considered is a lack of understanding of the framework

principles. The conceptual framework might be technical and complicated, and preparers, users
or stakeholders of financial reports might struggle to grasp its principles and concepts (Ngeno,
n.d). Therefore, this lack of knowledge can lead to misunderstanding or inappropriate
implementation of the framework's principles, resulting in financial reporting mistakes. Besides,
the conceptual framework is usually based on accounting concepts and theories that require
expertise. The technicalities associated with the framework can be difficult to understand for
small companies or independent investors that do not have an accounting qualification. This can
affect their capacity to make rational decisions based on financial statements (Grasso, n.d).

Last but not least, the subjectivity of the conceptual framework also contributed to the
difficulty of applying this framework to financial reports. The conceptual framework depends on
subjective assessments of what information is significant and how it should be displayed.
Because of this subjectivity, various perspectives and stakeholder arguments arise when applying
accounting principles (Elizabeth A. Gordon, et al., 2015) (Grasso, n.d). For instance, the
materiality concept in financial reporting includes the evaluation of whether certain information
is substantial enough to affect the determination of the person who uses financial statements.
This decision might be subjective since it depends on the circumstances and the accountant's
attributes.

Conclusion

To sum up, the conceptual framework is vital for accounting professionals to build up an
organized approach to seeing and comprehending financial information. Additionally, it ensures
the stability and comparability of financial statements, which are crucial for making decisions.
Even though the application of a conceptual framework in the financial reporting process is
essential, there are still a number of obstacles, including the subjectivity of this framework and a
lack of flexibility and understanding of the framework’s principles. To write financial reports that
accurately and effectively reflect the state of the company, accountants need to have a thorough
understanding of the framework’s concepts. Besides, financial statement users such as investors,
lenders, and stakeholders should evaluate the financial data of the organization as well as
exercise prudent judgment, resulting in well-informed decisions.

Total words: 2200

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